Buyer's credits for imports: A win-win proposition

Liberalisation of the economy, coupled with the significantly lower interest rates prevailing internationally, have thrown up an opportunity to top-notch companies to source global funds even for their working capital needs. Foreign currency funding options such as buyer's/supplier's credits are being increasingly preferred by companies in India.

In the wake of various positive developments on the external sector and the domestic front, the Reserve Bank of India (RBI) has been liberalising and rationalising procedures for forex transactions, both on the current and capital accounts.

Under the FEMA regime, limits for many current account transactions have been raised to facilitate easier drawal of foreign exchange by residents — individuals and corporates — in India.

On the capital account too, there have been relaxations in respect of foreign currency borrowings, both short and long term.

Foreign currency borrowings, which include, inter alia, external assistance, buyers' credit, suppliers' credit, NRI deposits, short-term credit and rupee debt, are a key component of India's overall external debt and its management. The measures taken represent a significant change in the approach of the central bank in the context of overall foreign exchange management.

As part of its new approach, the RBI recently came out with comprehensive guidelines on trade credits (hitherto referred to as short-term credits) that include buyers' and suppliers' credits which are extended for periods less than three years. Much clarity is now available on the purpose, cost, and so on.

For example, the new guidelines restrict the purpose of the credits for periods exceeding one year (and less than three years) to import capital goods only.

The RBI has also reiterated that ADs shall not issue guarantee, letter of undertaking (LoU) or letter of comfort (LoC) in favour of overseas lender on behalf of their importer constituents for trade credits without its (the RBI's) approval. A look at the broad perspective of these credits and a few related issues.

A period of six months has long been considered normal settlement time for import payments.

Liberalisation of the economy, coupled with significantly lower interest rates prevailing internationally, have thrown an opportunity to the top-notch companies to source global funds even for their working capital needs. Foreign currency funding options such as buyers'/suppliers' credits are being increasingly preferred by the companies in India.

Suppliers' credits are those short-term loans where the credit for imports into India is extended by the overseas supplier for a period of more than six months but less than three years. In the case of buyers' credits, short-term loans for payment of imports into India are arranged by the importer from a bank or financial institution outside India for maturity of less than three years. Both the arrangements needed specific approval from the RBI till September 2002.

To simplify the procedure for imports into India, the RBI, in September 2002, permitted the authorised dealers to approve proposals for short-term credit for financing, by way of either suppliers' credit or buyers' credit, of import of goods into India. The conditions to be fulfilled by the ADs are that:

  • the credit is extended for a period of less than three years;

  • the amount of credit does not exceed $20 million, per import transaction;

  • the `all-in-cost' per annum, payable for the credit does not exceed Libor +50 basis points for credit up to one year and Libor +125 basis points for credits for periods beyond one year but less than three, for the currency of the credit or applicable benchmark.

    Buyers' credits for imports are extended where payment terms can be sight or usance (the term usance refers to payment on deferred terms, as mutually agreed upon by the supplier and the buyer). These credits can be raised irrespective of whether the import takes place under an arrangement of letter of credit (LC) issued by a bank in India or whether the supplier sends the bills on collection basis.

    The foreign lender, generally a foreign office/correspondent of the importer's bank in India, would raise a loan account in the name of the buyer in its books on the strength of a guarantee, letter of undertaking (LoU) or a letter of comfort (LoC) from the importer's bank in India.

    Thus, under the arrangement of buyer's credit, the importer company in India need not retire the import bill on the due date; instead it can have the payment deferred to a future date (to a period less than three years from the date of Bill of Lading or the shipment date).

    In the mechanism of supplier's credit, on the other hand, the importer company opens a letter of credit (LC) from a bank in India under usance terms and the supplier company gets its bills (drawn under the LC) discounted from a foreign office/foreign correspondent of the LC opening bank in India.

    Thus, although according to the original payments terms, the payment is to be received on the expiry of the usance period, the supplier gets cash on the day of presentation of documents to the bank abroad extending the suppliers' credit.

    For the lending bank, the LC issued by the bank in India becomes the security and payment is assured at the end of the normal usance period. Low-funding cost, the prime motive behind the dependence on buyer's credit, is apparent in the table.

    The currency of the credit is usually the same as that of the invoice although there are wide differences in interest rates of the four major currencies. Mismatches in Libor (benchmark rate for lendings across the countries) of different currencies are usually negated by market forces through continuous movements in exchange rates between the currencies, propelled by demand/supply position of each currency. The over-all interest cost of buyer's credits is around 2 per cent.

    Taking into account other pay-outs in the form of handling charges (payable to the bank in India), hedging cost against exchange rate and interest rate risks, the cost would be around 3.5 per cent only.

    At present, rupee-dollar forward rates are at discount bringing the cost further down to the borrowers. Despite all these benefits, a few obstacles remain in truly popularising the product.

    One, not every import into India is sizeable for the bank to arrange for a buyers' credit from abroad. Generally, foreign banks/branches of Indian banks look for amounts in excess of $100,000 to give them income of some substance.

    Two, there is no incentive for the banks in India (other than small amount of commission that they book for issuance of LoUs/LoCs to the foreign lenders) to really push for the buyer's credits as these would eat into their (the banks') existing credit portfolio which is already under severe attack.

    Even the meagre return of around 5 per cent that the banks are now earning on working capital advances to corporates will be at stake, when the credit off-take is dented by the buyers' credits.

    Three, the foreign lenders take direct exposures on only a few corporates in the country. In the case of all other borrowers in India, they do not raise a buyer's credit in their books without a guarantee — LoU or LoC — from the bank in India arranging the credit.

    As per the extant guidelines (as reiterated by the RBI in their circular dated April 17, 2004), ADs shall not issue guarantee in favour of overseas lender on behalf of their importer constituent for trade credit without the approval of the RBI.

    This requirement necessitates the banks to seek approval from the RBI for every single-credit, thus delaying the whole process and defeating the very essence of liberalisation of rules for import finance in foreign currency.

    It must be noted here that banks have been issuing commitments of forex payments by way of LC as part of the international trade practice without seeking any approval from the regulatory authorities. Therefore, putting restriction on issuance of guarantee (also in the nature of a commitment) for arranging the buyer's credit would only result in delays which could prove crucial.

    After all, buyer's credits are a key short-term funding option for the corporates. If the corporates are to become truly global in terms of quality, efficiency, and so on, they should have access to funds at internationally competitive prices.

    Besides, many of the corporates do have systems in place to monitor the exchange risks and cost-effectiveness of the forex loans.

    Besides, the RBI also has the means and reporting systems in place to effectively monitor foreign currency exposures of the corporates to ensure against anyone going overboard.

    It is, therefore, hoped the RBI liberalises the guidelines further, relieving the commercial banks from seeking approvals for the buyer's credits. Banks on their part, would need to take due precautions while popularising the product to ensure that it will be a win-win situation for all concerned, without any party taking undue risks.

    P. V. B. N. Murthy : The author is AGM, SBI, CAG branch, Chennai.